Stephanie McCullough (00:06):

Welcome to Take Back Retirement, the show for women 50 and better, facing a financial future on their own. I’m Stephanie McCullough, and along with my fellow financial planner, Kevin Gaines, we’re going to tackle the myths and mysteries of “Retirement,” so you can make wise decisions toward a sustainable financial future. Through conversations and interviews, you’ll get the information and motivation you need, to move forward with confidence. And we’ll be sure to have some fun along the way. We’re so glad you’re here. Let’s dive in.

Stephanie McCullough (00:41):

So our regular listeners will remember that in our previous episode, Episode 32, Kevin and I shared our stories of the paths we took to become financial planners. But one of the things we didn’t talk about was an occupational hazard of being a financial planner. And this is that when we’re out and about in the world, we often need to bite our tongue. We’ll hear someone say something, maybe we’re at a family gathering. Maybe we’re in the checkout line at the hardware store and we’ll hear somebody state something about the financial world that’s wrong.

Stephanie McCullough (01:16):

And we really would be very happy to sit down to everybody in the hardware store and give them a 25-minute lecture on exactly how it works, but that probably wouldn’t go over so well. So the really great thing about having a podcast is that we get to sit in rooms with headphones on and microphones and give a 25-minute talk on stuff we think people should know and no one yells at us, whether people listen or not. Well, that’s a different question.

Stephanie McCullough (01:46):

Coming to you semi-live from the beautiful Westlakes Office Park in suburban Philadelphia, this is Stephanie McCullough and Kevin Gaines of Sofia Financial and American Financial Management Group. Say hello, Kevin.

Kevin Gaines (01:57):

Hello, Kevin.

Stephanie McCullough (01:58):

So today the topic we want to give an overview of is one that we hear people getting wrong a lot, we hear people getting confused about it and rightly so. Let’s be clear. It’s a super confusing topic and we’re talking taxes. We’re talking the estate and gift tax system, which is very different and separate from the income tax system. And yet, these are two federal tax systems that everyone should really kind of be aware of when they’re thinking about their retirement planning.

Kevin Gaines (02:30):

And before we go any further, Stephanie, I need to correct you on something.

Stephanie McCullough (02:34):

Tell me.

Kevin Gaines (02:35):

People probably yell at us all the time. It’s just with the beauty with the podcast is we don’t have to listen to it.

Stephanie McCullough (02:40):

That’s true. We don’t hear it.

Kevin Gaines (02:45):

But seriously. Yeah, frequently when we’re having conversations with clients and people trying to figure this stuff out it’s, “Oh, well I don’t have to pay tax on it.” Well, yeah, you don’t have to pay income tax on it, but you still got to deal with the estate tax or it bypasses the estate, but somebody’s paying taxes. Here it is. At the end of the day, the IRS is getting paid. Who and when, that’s what all this is about. It’s not if you’re going to pay tax. It’s when you pay the tax.

Stephanie McCullough (03:16):

And being smart about it. Planning ahead. We’re not advocating skipping out on your taxes either. We’re just trying to give you – this is going to be a super high level overview, very big picture. Obviously, we recommend everybody work with tax professionals when you’re in the weeds dealing with this on your personal situation. And at the same time, we think it’s useful to have a big picture understanding of the estate and gift tax system.

Kevin Gaines (03:42):

Right. Because if your accountant says, “Hey, we should do this or your estate planner says, “We should do that.” You’re just going to sit there and go, “Okay, sure.” If you’re at least not aware of the vocabulary, you’re just going to be completely lost in who knows what you end up doing. So, hey, this is this.

Stephanie McCullough (04:02):

And our first point is just that, that these are very two distinct systems. The income tax system is extremely different from the estate and gift tax system. They’ve actually got nothing to do with each other. And the same dollar or multiple dollars can be taxed both ways, and like Kevin was say avoiding tax in one of the systems it doesn’t really tell you anything about how it’s going to be treated in the other system.

Kevin Gaines (04:27):

Right. Hey, let’s start for the weeds right now. And first thing we want to talk about is the estate tax. So you hear the terms estate and gift. For the purpose of this conversation, they’re essentially the same thing. So gift tax is stuff when you’re alive. The estate tax is when you’re dead.

Stephanie McCullough (04:46):

It’s all the same thing. In the federal tax code, the estate and gift tax, they’re connected. And we’ll explain why, but yeah, the point is these things go together.

Kevin Gaines (04:55):

And probably one of the easiest ways to try to keep this straight is think of when we’re talking estate and gift taxing, we’re talking about a disbursement tax. The money is being sent out, again, whether you’re alive or dead, separate conversation, but it’s money you’re giving out and how much of it is going to be taxed and at what rate.

Stephanie McCullough (05:18):

And the tax is on the giver or the person bequeathing it, not on the receiver.

Kevin Gaines (05:24):

Right.

Kevin Gaines (05:24):

And again, getting back to income tax versus estate and gift tax. Yes, estate tax on the giver, income tax on a receiver. You know you receive a wage, you pay an income tax.

Stephanie McCullough (05:37):

And we do want to point out, too. Here’s our second caveat. First caveat, get help from a real certified tax professional. Second caveat, we’re talking about the federal systems. States are a whole different ballgame. As you know, there’s 50 of them plus some territories. They have their own systems and we’re not even going there.

Stephanie McCullough (05:56):

Some states have an estate tax, which we just said was a disbursement tax, a tax on the one who is giving. Some states like the one we happen to live in, Pennsylvania, have an inheritance tax, which is a tax on the receiver and it’s wacky. So pay attention to your states. We’re not talking about that today.

Kevin Gaines (06:14):

So first thing we need to talk about, Stephanie, is exclusion amounts. So what are exclusion amounts?

Stephanie McCullough (06:24):

So in both these situations, a gift, which is when you’re living and estate tax when you’ve passed away, there’s an exclusion, which is the amount that you can pass on with no tax. It’s kind of like a deduction. It’s the amount that you can pass without tax being levied.

Kevin Gaines (06:43):

So why are these exclusion amounts important? Well, if you are below the exclusion amount, no tax. The IRS doesn’t care. You’re home free. Do whatever you want below that amount. They’re good. Anything over and above that exclusion amount, that’s when they’re sticking out their hands saying, “Gimme gimme gimme” when it comes to these taxes. That’s why the numbers come into play so much.

Kevin Gaines (07:10):

Now, if you happen to be married, there’s yet another number to worry about. Well, technically it’s not a number. It’s a symbol. It’s a little eight on its side, unlimited. Well, technically that’s infinity, but if you are married you can pass unlimited amount of money to your spouse either in terms of gift or estate.

Stephanie McCullough (07:34):

Mm-hmm. It’s called the unlimited marital deduction. So no tax if you are giving something to your spouse, again, while you’re living or after you’ve passed away.

Kevin Gaines (07:44):

Right. That’s a key thing. In most people’s estate plans is, it all goes to the wife, the husband, whoever. As long as you’re married the IRS says, “Good, have fun with it.” Again, states may have their own rules, but just to reiterate we’re talking about federal on this stuff. So there’s our exclusion definition. Stephanie, gift tax, this lifetime giving, what’s it all about?

Stephanie McCullough (08:16):

So the gift tax or what most people think about actually, when they’re thinking about annual giving is, and remember and we’re not talking about charities now. Charities, that’s to do with the income tax. You can get deductions if you donate to charities and there’s rules around that. Not talking about that. We’re talking about when you’re giving to another person, this is a person-to-person gift of assets or cash during your lifetime, there is an annual gift tax exclusion, an amount that you can give to someone with no tax being levied.

Stephanie McCullough (08:47):

And a lot of people had this number in their heads. Last year, 2021, it was $15,000. Things go up periodically with inflation. This year, 2022, it’s $16,000 that I could give to anyone of my choosing with no tax. And in fact, I could give to as many anyones as I felt like. I could give $16,000 to Kevin. I could give $16,000 to my cat groomer. I could give $16,000 to the person who cuts my hair all in gifts and no tax.

Kevin Gaines (09:19):

Note: Stephanie, did you mention anybody you were related to in that example?

Stephanie McCullough (09:24):

Not today.

Kevin Gaines (09:26):

So that’s a key point about the gift tax. This isn’t blood relations or connected legally or anything, you could literally give $16,000 to the first person you meet on the street. And as far as the IRS is concerned, that’s just as good as giving it to a grandchild or a sibling or whatever. So this $16,000 in 2022, this is a person to person number. So it’s not tax return to tax return. A lot of moving parts here.

Kevin Gaines (10:01):

In an attempt to clarify this, let’s go with an example. Let’s assume you’ve got grandma and grandpa, and they have two kids and those kids are married and they each have two kids. So for the purpose of this part of the example, we’re talking about eight people. How much can you give, Stephanie?

Stephanie McCullough (10:27):

Well, grandma could give $16,000 to each kid, each kid’s spouse and each grandkid. But grandpa can also give $16,000 to each kid, each kid’s spouse and each grandkid. So this is the person-to-person part. It’s not talking about a tax return. So a married couple if they’re filing jointly is one tax entity; however, the gift tax exclusion applies to individuals. So each spouse can give the $16,000 to each person.

Kevin Gaines (11:58):

Right. And then say they really like the neighbor kid helping them out, mowing their yard, whatever this kid’s done to curry their favor, so to speak. Can they give another 16 or even $32,000, Stephanie?

Stephanie McCullough (11:16):

Sure. Again, it’s not family connected at all. So grandma, grandpa could give to each of these family members and they could each give $16,000 to the neighbor kid. So if we add that up, that’s nine people each receiving 16 from grandma, 16 from grandpa. That’s $288,000 in 2022 that grandma, grandpa could be gifting in our example.

Stephanie McCullough (11:38):

Now, this kind of gets to the connection part of it. Why do they want to do this? Because they love their family and they love the neighbor who mows the lawn. But from a tax perspective, why would they want to be gifting this money, Kevin?

Kevin Gaines (11:53):

Well, now we get back to the simple answer, reduce their estate. How do you want to reduce your estate? It’s simple because there’s this other number to worry about, the estate tax exemption, which is for 2022 a little over $12 million. When you die if your estate is under $12 million, you don’t have to pay your estate tax. Your tax rate is zero, it’s an exclusion amount. And if you’re over that, then obviously you’re going to have to pay some sort of tax. And that tax rate is up to 40%. So it’s something you ideally would like to avoid if you can.

Kevin Gaines (12:37):

If your estate’s $100 million, you’re probably not going to be able to reduce it so you’re not going to worry about it. But you’re looking at the numbers and “Hey, we’re at $12.5 million or $13 million,” then maybe you want to do some things to try to lower that number assuming you care about your beneficiaries.

Kevin Gaines (12:58):

Because to be brutally honest, you’re dead. You may not say, “Hey, they’re going to get it all anyway. If they got to pay some, go for it.” But let’s assume you do want to try to maximize how much your beneficiaries inherit. So doing some gifting while you’re alive will allow you to reduce that number and avoid paying the IRS any more money than you have to.

Stephanie McCullough (13:24):

So this estate tax exclusion, each individual gets, again, this estate and gift tax is individual by individual. You get this lifetime exclusion amount, it’s called. So Kevin mentioned right now it’s a little bit over $12 million, but that number bounces around all the time. Congress changes the tax laws a lot. So previous to the current tax law that’s in force, it was around $5 million per individual. Well, $5 million is a lot less than $12 million. And we’re not going into all the details of tax law and how law is made because that’s sausage-making and we don’t want to dive in there.

Stephanie McCullough (14:03):

However, the current law as it stands is set to sunset, which means fade out into history on January 1st of 2026. So if nothing changes, (it probably will), but if nothing changes, that lifetime exclusion amount goes down from $12 million to $5 million in 2026. So if you’re sitting there thinking, “Well, hey, all this stuff I own is only about $6 million and the exclusion’s 12, I don’t have to worry about it.” … Things bounce around. Just know that Congress can change their minds anytime they feel like it.

Kevin Gaines (14:38):

And frequently do. $12 million may sound like a lot of money, but it can also add up fast. Something to be aware of.

Stephanie McCullough (14:49):

Because your home’s included there.

Kevin Gaines (14:50):

Homes. If you own a farm. Maybe you own a farm far, far away from everybody. All right, so the land isn’t worth all that much. But as you get this, what do they call it? Suburban sprawl.

Stephanie McCullough (15:02):

Mm-hmm.

Kevin Gaines (15:03):

All of a sudden, you may find your land values going up and you could easily end up over the $12 million through no fault of your own.

Stephanie McCullough (15:11):

Heck, owning a business. If anybody owns some Bitcoin like you never know, you never know. So again, we just want to arm you with a little bit of this information. Here’s an important part. Again, remember we mentioned that unlimited marital deduction. So if I have $20 million and I pass away, it can all go to my spouse with no tax. But Kevin, there’s something else that also passes to my spouse in that example.

Kevin Gaines (15:40):

Yes. The fun part, which is the exemption amount. Which means you have $12 million and you pass it all to your spouse, you actually didn’t use any of that exemption amount because it all went to your spouse and no tax was due. So the surviving now has for 2022, $24 million of room.

Stephanie McCullough (16:09):

So their lifetime exclusion goes from 12 to 24.

Kevin Gaines (16:13):

Right. So now all of a sudden, “Hey, the math’s going to change.” You don’t have to worry about this smaller, “smaller amount.” You now have a lot more room to play with.

Stephanie McCullough (16:27):

Meaning not be taxed on.

Kevin Gaines (16:29):

Meaning not be taxable. So now all of a sudden going back to our farm being impacted by suburban sprawl. Yeah. Hey, maybe now it’s not as big of an issue. And this was actually part of the reason they brought this transfer of the exemption amount in was to account for a lot of this family stuff, family-owned business, farms, joint assets, they exist. So, in a nutshell, there’s your estate tax number. So it’s $12 million if you don’t use it, again, for 2022, if you don’t use it, it passes to your spouse and voila, there’s more money that can be passed to whoever you want.

Kevin Gaines (17:10):

However, one thing and this gets back to the intro with Stephanie that she was saying, talking to people in hardware stores. There are misconceptions, there are stuff we hear. So Stephanie, what would you say is probably the biggest misconception when it comes to this gift tax?

Stephanie McCullough (17:32):

Ah, the one I hear all the time from clients, from friends is that, “Well, my parents can only give me $16,000 a year.” Like there’s somebody in the federal government who’s going to come knock on their door and hand them a ticket if they give more than that annual exclusion amount. And that’s not true. You can gift more than the $16,000 to any one individual. And here’s again where the systems are connected.

Stephanie McCullough (18:02):

What happens is let’s say I feel like giving anybody, not my spouse because that’s unlimited. I want to give someone $20,000 in a year. I could choose to pay gift tax, but that’s silly. What I would do instead is file one extra piece of paper, one extra form with my tax return saying that I have used $4,000 of my lifetime exclusion amount this year to gift to this individual.

Stephanie McCullough (18:33):

So I can actually give as much as I want. I can give $100,000 to somebody and use $100,000 minus $16,000 of my lifetime exclusion in this year. And then of course, I need to file that piece of paper. I need to keep track that when I pass away, my estate would have the $12 million minus the 100,000 that I gifted in 2022.

Kevin Gaines (18:50):

Question for you.

Stephanie McCullough (18:56):

Mm-hmm.

Kevin Gaines (18:59):

What if for whatever reason you give away 12 million this year? Now it’s 2026, 2027 and miraculously the Congress hasn’t played with the estate tax limits or anything. And we’ve dropped back down to $5 million. What happens to that $7 million, the difference between the 12 this year and the five in 2026?

Stephanie McCullough (19:23):

Yeah. So that’s interesting because in effect because they’re connected and yet the gift is annual and the estate tax is lifetime. If I choose to gift and use up all my lifetime exclusion in 2022, I can do that and that’s going to be governed by the amount in 2022.

Stephanie McCullough (19:44):

And then let’s say I passed away in 2027. Hopefully, it’s a lot longer than that, but I pass away when the exclusion is a lot lower than that $12 million. There’s no repercussions. They’re not going to come back at my estate and say, “Oh my gosh, she owes estate tax on $7 million.” That’s not how it works. So it’s kind of an interesting interplay between this annual gift tax and a lifetime estate tax.

Kevin Gaines (20:07):

Right. And to clarify, so if you use all the $12 million this year, you now have zero so when you die even if you only have $2 left in the bank, that $2 is subject to estate tax.

Stephanie McCullough (20:21):

Unless the lifetime exclusion is $24 million or turns into $50 million when I die. That I’ve only used 12, right?

Kevin Gaines (20:30):

Exactly.

Stephanie McCullough (20:31):

Yeah. But assuming that I’ve used it all up, then yes, anything I own that’s in my estate. And the estate is everything that an individual owns at the time of their death. That’s what’s calculated added up to figure out what the estate tax is. Anything I own would be taxed in that situation because I’d already used up my exclusion.

Stephanie McCullough (20:53):

But what that means is back to our grandma and grandpa example. They’re not limited to gifting the $16,000 per each person. Let’s say they wanted to give $25,000 each to the two kids, the two spouses, the four grandkids and the kid who mows the lawn. That’s $450,000 out of their estate just for adding one more form to their tax return saying that they’ve used some of their lifetime exclusion this year.

Kevin Gaines (21:20):

Right. So it comes down to the name of the game is if you are a little bit over that number, you’re going to be looking for ways to lower that number.

Stephanie McCullough (21:30):

What number?

Kevin Gaines (21:31):

The estate, the value of your estate. Good point. Yeah, you want to reduce that if you’re just a little bit over, it’s going to be worth gifting or other things to do that. So understand, annual doesn’t exclude being able to use the bigger number if you want to and still avoid having to pay a gift tax.

Stephanie McCullough (21:54):

Yes, exactly. Exactly. So yeah, the misconception I hear is not allowed to give more than 16 or they’re going to pay tax if they give more than 16, but that’s not true. All right, Kevin, what’s a big misconception that you hear? In fact, you’ve been hearing quite a bit last week and this week.

Kevin Gaines (22:11):

Yes. Unfortunately, I had a client pass away and been working with her kids on a lot of these details. Interestingly, her estate is a little over this amount and we were talking about different things we can do to reduce that amount. And one question that has come up is trying to avoid probate and the estate taxes. Here’s the popular misconception, “Oh, I want to avoid probate because if I can do that, then I’m not going to pay estate tax.” Incorrect. The two have nothing to do with each other.

Stephanie McCullough (22:58):

What is probate, Kevin, in a 30-second overview?

Kevin Gaines (23:01):

Probate is basically the court saying a blessing over your will and anything that’s going to pass through your will, the court’s going to have to approve. And normally it’s just a signature. The big problem with probate is it has some costs, but it’s more of an inconvenience and it takes time to have to deal with the court system in order to get this money dispersed.

Stephanie McCullough (23:29):

And back to our Episode 31 on trusts, it’s also public. Not that anyone’s necessarily looking, but like that’s public record anything that passes through probate.

Kevin Gaines (23:39):

Real quick example. Every time a celebrity dies without a will, not let alone the estate planning. It’s always, well, at least among us, it’s always big news. It’s like, “Oh, how could somebody so rich and famous make these estate planning mistakes?” We know they made the mistakes because the stuff is public. It’s going through probate. Avoiding probate is convenience and privacy. So how do you avoid probate? You pass it through beneficiaries instead of through the will. Over simplification, but that’s pretty much it an in a nutshell.

Kevin Gaines (24:16):

IRAs, they pass by beneficiary forms. Life insurance passes through by beneficiary forms. So those avoid probate because they didn’t go through the will. Unless of course you made your beneficiary your estate or your will. But that aside, it’s still part of your estate. If you have a $6 million IRA and a $10 million life insurance policy, you have a $16 million estate, zero probate. But your estate is $16 million and now we’re possibly talking estate taxes. Yeah, so understand in a nutshell you avoid probate to simplify your life, not to avoid taxes.

Stephanie McCullough (25:09):

So we hope you found this helpful. We tried to keep it concise. That’s sometimes a challenge with us, but we wanted to just equip you with an overview of this estate and gift tax system. They’re connected. There’s annual stuff. There’s a lifetime stuff. There’s an unlimited marital deduction. Some of these key pieces of information we hope you’ll find useful in planning in thinking about, and dealing with family members.

Stephanie McCullough (25:35):

We’re of an age where family members are starting to pass away. Maybe you’re going to have to be executor or involved in some things. So hopefully you found this helpful. We appreciate you joining us. As always, thanks for being with us. We’ll talk to you next time. It’s goodbye from me.

Kevin Gaines (25:51):

And it’s goodbye from her.

Stephanie McCullough (25:55):

Be sure to subscribe to the show and please share it with your friends. Show notes and more information available at takebackretirement.com. Huge thanks for the original music by the one and only, Raymond Loewy through New Math in New York. See you next time.

Disclaimer (26:09):

Investment advice offered through private advisor group, LLC, a registered investment advisor. Private advisor group, American Financial Management Group, and Sofia Financial are separate entities. The opinions voiced in this material, are for general information only and are not intended to provide specific advice, or recommendations for any individual security. To determine which investments may be appropriate for you, consult your financial advisor, prior to investing. This information is not intended to be substitute for individualized tax advice. Please consult your tax advisor regarding your specific situation.